Although banks’ earnings were better than anticipated, sone figures indicate that the broader economy is declining, as retail sales and manufacturing output fell more than projected. Despite the challenges, most believe the Federal Reserve will raise interest rates next month.
Loretta Mester of the Federal Reserve, explained there should be another rate hike as the monetary policy will need to be more restrictive this year, with the fed funds rate rising above 5% and the real fed funds rate remaining positive for an extended period.
Thus far, monetary policymakers’ efforts to work liquidity out of the system have been complicated, particularly with rates at the back end falling, said Kai Volatility’s Cem Karsan in a conversation with TD Ameritrade Network. CrossBorder Capital confirms. Liquidity has been on an upward trend since October, partly due to China’s efforts to recover from Covid-19 restrictions and the collapse of the UK gilts markets.
“Our original conjecture that Central Banks have effectively split their policy tools to use quantitative or balance sheet policies (QE) to ensure financial stability, whilst targeting inflation with interest rate policy is becoming more widely discussed in the media,” CrossBorder Capital’s Mike Howell said. “This splitting of roles can explain why interest rates have risen at the same time that Global Liquidity is turning higher.”
Accordingly, with the recent response to the bank issues cutting down tail risks for the S&P 500 (INDEX: SPX), markets are positioned to stay contained with falling implied volatility (IVOL) and correlations, as well as the passage of time, positioning-wise, key market boosters, Karsan added.
It’s appears the SPX may strengthen before it weakens with risk indicators, including IVOL measures, rising with the SPX. Physik Invest agrees: buy call structures on any weakness and monetize them into strength to finance long dated put structures.
It is better for traders to limit their expectations and stay the course, despite the big gap between IVOL measures like the Cboe Volatility Index and Merrill Lynch Option Volatility Estimate or MOVE, and big bets on market movement in the VIX complex, potentially to hedge against the breach of the US debt limit as soon as June.
As an aside, recent VIX hedging makes sense given that a breach of the debt limit likely results in recession, a ~20% drop in equities, and a volatility spike, Moody’s said.
Quoting The Ambrus Group’s Kris Sidial, “When volatility starts to move, it moves at a higher rate than S&P volatility which is something that’s really important for the call option buyers,” which are stepping in aggressively as we’ve shown in the past letters.
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